What is Pricing power?
It shows most clearly when costs rise: a firm that can pass the increase through protects its margins, while one competing mainly on price has to absorb it and its margins shrink. Gross margin is the usual evidence, and its trend matters more than its level: a margin that holds while rivals discount points to pricing power, and an eroding margin is often the first sign of commoditisation. Pricing power depends on how easily customers can switch to other products or sellers, and it can change over time.
Also called price-setting power, cost pass-through
Unit cost rises 10% (illustrative, volumes assumed unchanged)
- Before (price $100, cost $60): gross margin
- 40.0%
- New cost
- $66
- Firm that raises its price 10% to $110: gross profit · margin
- $44 · 40.0%
- Firm that must keep $100: gross profit · margin
- $34 · 34.0%
- Margin gap (percentage points)
- 6.0The real test is the assumption in the title: whether customers stay after the price rise.
Pricing power is one channel, not a verdict
A business that passes costs through can still be hurt in other ways, for example when rising rates lower the value of distant cash flows. Net the effects for the specific business.